The World Bank has warned that leading central banks risk sending the global economy into a “devastating” recession next year if policymakers raise interest rates too high over the months ahead and stress financial markets.
The Washington-based organisation called on monetary authorities in the big economies to co-ordinate their actions to reduce the overall amount of tightening.
Central banks, led by the US Federal Reserve, have embarked on a series of aggressive rate rises over the course of 2022 in a bid to tame inflation that is at, or close to, double figures in several advanced economies for the first time in decades.
Energy and food prices have surged following Russia’s invasion of Ukraine in late February, triggering a cost of living crisis.
To avoid letting inflation rip, the World Bank urged governments to provide targeted relief to vulnerable households instead of relying on tighter monetary policy.
World Bank president David Malpass said momentum in the global economy was sliding and more countries were already falling into recession. “My deep concern is that these trends will persist, with long-lasting consequences that are devastating for people in emerging market and developing economies,” he added.
He called for more action to boost production to ease inflationary pressure, rather than all the focus being on curbing spending. Increased investment would, he said, “improve productivity and capital allocation, which are critical for growth and poverty reduction”.
The World Bank did not produce new forecasts for the global economy, but noted that the outlook for 2023 had been sliding as rich and poor countries alike responded to high inflation this year by seeking to limit spending.
“Central banks around the world have been raising interest rates this year with a degree of synchronicity not seen over the past five decades — a trend that is likely to continue well into next year,” the World Bank said.
The warnings come ahead of crucial policy votes at the Fed and Bank of England next week. The US central bank is expected to raise rates by 75 basis points for the third meeting in a row on Thursday, while UK borrowing costs are likely to rise by 50 basis points.
The expected rises in global interest rates would bear down on inflation, but not enough to meet central banks’ targets, which are usually around 2 per cent, the World Bank warned. Core global inflation, excluding energy, was still likely to be running at a rate of 5 per cent next year — twice the pre-coronavirus pandemic rate.
If such a level of inflation persuaded central banks to become even more aggressive, global economic growth would drop to 0.5 per cent in 2023, according to the World Bank.
That would meet most definitions of a global recession just three years after the last one, the World Bank added, because with population growth, average global incomes would be falling.
In its modelling, the bank said there needed to be some tightening of monetary policy, but this should be accompanied by every effort to ease bottlenecks both internationally and domestically to allow production to increase without stoking inflation.
This includes boosting the supply of commodities, food and energy to alleviate much of the global inflationary forces, alongside investing to decarbonise economic growth.
The bank’s findings have been echoed by former IMF chief economist Maurice Obstfeld, now a senior fellow at the Peterson Institute for International Economics.
“Just as central banks, especially those of the richer countries, misread the factors driving inflation when it was rising in 2021, they may also be underestimating the speed with which inflation could fall as their economies slow,” said Obstfeld, urging them to be less “zealous” in raising interest rates.
“By simultaneously all going in the same direction, they risk reinforcing each other’s policy impacts without taking that feedback loop into account,” he added.